Amazon Effect Impacts Inflation Dynamics

Every year, the Federal Reserve Bank of Kansas City holds a symposium that is participated by prominent central bankers, finance ministers, academics, and financial market participants from around the world. The 2018 Economic Symposium took place on August 23rd – 25th 2018 with the theme "Changing Market Structure and Implications for Monetary Policy". At the symposium, Alberto Cavallo, Professor at Harvard Business School, presented his paper about the investigation of how prices are influenced by the largest online retailer, Amazon.

Cavallo's main finding is that the competition initiated by Amazon has caused a greater frequency of price changes than traditional retailers such as Walmart. Because Amazon covers a wide and large scale of market, it has a very strong influence on the marketplace. The name ‘Amazon Effect’ is an acknowledgment of Amazon's initial and sustainable dominance in online sales. This domination results in disruption in the retail market as customers are more likely to buy goods online rather than going to the physical store.

On his paper, Cavallo revealed that the cause of the ‘Amazon Effect’ could occur is due to the algorithms that caused prices to continue to fluctuate. Suppose that if an item has a lot of demand from buyers, the price of that item becomes more expensive, then other retailers will automatically follow that price because of their tendency look up at the dominant party. In this case, this phenomenon has been broadly replicated, leading to a high level of price uniformity throughout the country.

In other words, Amazon has created a space, with precise, rapid swings in prices, which is not always related to the general factors of supply and demand. Cavallo also showed that from 2008 to 2017, the average duration of price changes of goods sold at large U.S. retailers like Walmart fell from about 6.5 months to about 3.7 months as online purchases contributed for an ever-growing share of total retail sales.

The ‘Amazon Effect’ is the impact the digital marketplace has on the traditional business model regarding consumer expectations and the new competitive landscape. The idea that sellers cannot change prices immediately in response to changes in supply and demand is exactly what gives interest rates in the mainstream model to have an effect on the economy as a whole.

Cavallo also found retailers more responsive to changes in shock factors as well, such as rising oil prices, weakening currency values, and import tariffs. When one or more of these factors happen, prices will become more sensitive and companies can more quickly determine prices to the customers. "The implication is that retail prices are becoming less isolated from this general national shock," said Cavallo on his paper.

In that case, nothing can be done by the central bankers to guide supply and demand back to the balance point as the prices adjust instantaneously in response to shocks. “For monetary models and empirical work, my results suggest that the focus needs to move beyond traditional nominal rigidities: labor costs, limited information, and even ‘decision costs’ will tend to disappear as more retailers use algorithms to make pricing decisions,” Cavallo stated on his paper.

Sources:

Financial Times

Bloomberg

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